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A License to Print Money

April 16, 2010 | About:
Harry Long

Harry Long

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  1. Imagine the U.S. government privatized social security and allowed private companies to manage the assets of social security funds.

  2. Imagine that you could decide which company managed your social security savings, but that you could not take money out of the system until retirement.

  3. Imagine that 80% of people stayed with the same company their whole lives.

  4. Imagine that the management companies merged until only 3 dominated the entire industry.


Now stop dreaming. It has happened in Chile. PVD is the dominant “AFP” in Chile. Every month, Chileans have a fixed % of their paycheck automatically deducted and sent to an AFP of their choice. This happens rain or shine, bull or bear market, making Chile's AFPs, in essence, the only asset management firms in the world with virtually guaranteed positive fund flows, save for the risk of unemployment.

As an added bonus, Chile's strong development, economic growth, and almost non-existent corruption (the U.N. ranks Chile as less corrupt than the U.S. in its annual rankings) make strong wage growth over the long term virtually assured, further adding to long term fund flows and AFP profits.

30% of the assets in the entire system have ended up at Provida (PVD), which trades as an ADR. As you might expect, you could almost set your watch to their cash flows.

Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

CFO (millions) 41 52 56 39 51 45 73 78 79 129

As an added benefit, capital expenditures, like at any asset management firm, are almost non-existent, so the company pays out large, and growing, dividends.

At less than 10X cash flow, the company is a steal. You have the benefits of an asset management firm, with market dominance, and without the volatility in fund flows (employed Chileans must pay in, by law).

However, there is another wrinkle in these companies which the market does not understand, but is really another bonus. I am going to grossly over-simplify, but in essence the AFPs keep on their balance sheet reserve funds which must be paid out if their funds have catastrophically bad performance in relation to the funds run by their competitors. Guess where the reserves come from? You guessed it, fees from their customers. Predictably, the AFPs have almost identical asset allocation, assuring that they almost never pay out to shareholders from their reserves.

As an added bonus, the AFPs themselves get to book any increase in the value of reserve funds as profit, and keep them. In essence, it is almost like owning an insurance company which never has to pay out. When markets drop, the AFPs also book a loss on their reserve funds. However, the cash flows from their main business is unaffected, which is why the profits recorded by PVD and its competitors look more volatile than the underlying free cash flow generated from their businesses.

The earthquakes in Chile have knocked PVD's stock down a little from its 52 week high. Longer-term, I believe the fundamentals remain intact.

Disclosure: Long PVD


Rating: 0.0/5 (0 votes)

Comments

DaveinHackensack
DaveinHackensack - 4 years ago
PVD is the dominant “AFP” in Chile.Why don't you specify and translate what "AFP" stands for?

Sivaram
Sivaram - 4 years ago


I'm not too familiar with financial firms but is it proper to value them using cash flow multiples?

In any case, assuming the cash flow method is ok, how does this 10x multiple make it cheap? American asset managers have an average P/CF of 9.9 (according to Morningstar, if I'm reading it correctly) with distressed ones like Legg Mason at 6.3 (these are not pension fund managers and I'm looking at the valuations for various types of asset managers.) Yes, this appears to be an oligopoly but I'm not sure if it's cheap.

The price is a very important point because there is massive political risk. If you hop over the border to Argentina, it wasn't even an year ago when it nationalized private pensions. The situation may have been different and the structure of the industry could be different but if that happens, this company is worth little.

None of this means that one should avoid this company. I don't know anything about this company or its environment but I just don't see how it can be considered cheap.

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